The agency problem, investment decision, and optimal financial structure

Jyh-Bang Jou and Tan Lee

The European Journal of Finance, 2004, vol. 10, issue 6, 489-509

Abstract: This article constructs a real options model in which a firm has a privileged right to exercise an irreversible investment project with a stochastic payoff. Supposing that the investment costs are fully sunk, a firm that exercises the investment option after debt is in place will then choose a better state to exercise this option as it issues more bonds. This debt-overhang phenomenon, however, benefits the firm since waiting is itself valuable. Accordingly, the firm will both exercise the investment option later and issue more bonds as compared with a firm that issues bonds upon exercising the investment option.

Keywords: bankruptcy; financial structure; irreversible investment; limited liability (search for similar items in EconPapers)
Date: 2004
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Citations: View citations in EconPapers (2)

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DOI: 10.1080/1351847032000168669

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